Securities and Exchange Board of India Vs. Rakhi Trading Pvt. Ltd.

[Civil Appeal No. 1969 of 2011]

[Civil Appeal Nos. 3174-3177 of 2011]

[Civil Appeal No. 3180 of 2011]

KURIAN, J.

1. Fairness, integrity and transparency are the hallmarks of the stock market in India. The Securities and Exchange Board of India (hereinafter referred to as "SEBI") is the vigilant watchdog. Whether the factual matrix justified the watchdog's bite is the issue arising for consideration in this case.

2. There are two sets of party respondents - the traders and the brokers. SEBI proceeded against the traders for violation of Regulations 3(a), (b) and (c) and 4 (1), (2)(a) and (b) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 (hereinafter referred to as "the PFUTP Regulations"). In the case of brokers, the charge is that they also violated Regulations 7A (1), (2), (3) and (4) of the Securities and Exchange Board of India (Stock Brokers and Sub-brokers) Regulations, 1992.

3. As the matter before us involves three traders and three brokers, for convenience, we have extracted the dates of the decision of the Adjudicating Officer (hereinafter referred to as "A.O.") and the Securities Appellate Tribunal (hereinafter referred to as "the SAT") in the table below:

S. No.

Name of the Party

Trader/ Broker

Date of A.O's order

Date of SAT's decision

Rakhi Trading Private Limited ("Rakhi Trading")

Trader

26.03.2009

11.10.2010

Tungarli Tradeplace Private Limited ("Tungarli")

Trader

30.04.2010

16.11.2010

TLB Securities Limited ("TLB")

Trader

16.03.2009

26.10.2010

Indiabulls Securities Limited ("Indiabulls")

Broker

25.02.2009

26.10.2010

Angel Capital and Debt Market Limited ("Angel")

Broker

22.05.2009

26.10.2010

Prashant Jayantilal Patel ("Prashant")

Broker

31.08.2009

26.10.2010

SAT set aside the decisions of the A.O. in all the aforementioned cases. Aggrieved, SEBI is before this Court under Section 15Z of the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as the "SEBI Act").

4. Both the facts and the law are complex, and hence, we shall first analyse the legal framework.

5. The Securities Contracts (Regulation) Act, 1956 was introduced "... to prevent undesirable transactions in securities by regulating the business of dealing therein, by providing for certain other matters connected therewith".

Section 18A dealing with contracts in derivatives was introduced with effect from 22.02.2000. The provision reads as follows:

"18A. Contracts in derivative.-Notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are -

(a) traded on a recognised stock exchange;

(b) settled on the clearing house of the recognised stock exchange; or in accordance with the rules and byelaws of such stock exchange;

(c) between such parties and on such terms as the Central Government may, by notification in the official Gazette, specify."

"Derivative" is defined under Section 2(ac) of the 1956 Act, which read as under:

"2(ac)] "derivative" includes-

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices, of underlying securities.

(D) such other instruments as may be declared by the Central Government to be derivatives;"

6. "Option in securities" is defined under Section 2 (d) of the 1956 Act, which reads as under:

"2(d) "option in securities" means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities."

7. The term "securities" is defined under Section 2(h) of the 1956 Act, which reads as under: "2(h) "securities" include-

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.

xxx xxx xxx

(ia) derivative;"

8. In 1992, the SEBI Act was introduced "...to provide for the establishment of a Board, to protect the interest of investors in securities and to promote the development of and to regulate, the securities market and for matters connected therewith or incidental thereto".

9. Section 15HA of the SEBI Act provides for penalty for fraudulent and unfair trade practices. The provision reads as under: "15HA. Penalty for fraudulent and unfair trade practices.- If any person indulges in fraudulent and unfair trade practices relating to securities, he shall be liable to a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher."

10. Adjudication is provided under Section 15I. Section 15T provides for appeal to SAT against any order made by an Adjudicating Officer and Section 15Z provides for an appeal to Supreme Court against an order passed by the SAT "...on any question of law arising out of such order.."

11. Under Section 30 of the SEBI Act "....the Board may, by notification, make regulations consistent with this Act and the Rules made thereunder to carry out the purposes of this Act." The PFUTP Regulations were notified on 17.07.2003.

12. Regulation 2(1)(b) of the PFUTP Regulations provides the definition of "dealing in securities", which reads as under: "2(1)(b) "dealing in securities" includes an act of buying, selling or subscribing pursuant to any issue of any security or agreeing to buy, sell or subscribe to any issue of any security or otherwise transacting in any way in any security by any person as principal, agent or intermediary referred to in section 12 of the Act."

13. Chapter II of the PFUTP Regulations comprising Regulations 3 and 4 deals with the prohibition of fraudulent and unfair trade practices relating to securities in the market. Regulation 3 speaks of prohibition about certain dealings in securities and Regulation provides for prohibition of manipulative, fraudulent and unfair trade practices. The regulations relevant for the purpose of the present case read as under:

"3. Prohibition of certain dealings in securities No person shall directly or indirectly-

(a) buy, sell or otherwise deal in securities in a fraudulent manner;

(b) use or employ, in connection with issue, purchase or sale of any security listed or proposed to be listed in a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of the Act or the rules or the regulations made there under;

(c) employ any device, scheme or artifice to defraud in connection with dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange;

(d) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person in connection with any dealing in or issue of securities which are listed or proposed to be listed on a recognized stock exchange in contravention of the provisions of the Act or the rules and the regulations made there under.

"4. Prohibition of manipulative, fraudulent and unfair trade practices

(1) Without prejudice to the provisions of regulation 3, no person shall indulge in a fraudulent or an unfair trade practice insecurities.

(2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice if it involves fraud and may include all or any of the following, namely:-

(a) indulging in an act which creates false or misleading appearance of trading in the securities market;

(b) dealing in a security not intended to effect transfer of beneficial ownership but intended to operate only as a device to inflate, depress or cause fluctuations in the price of such security for wrongful gain or avoidance of loss;

xxx xxx xxx

(e) any act or omission amounting to manipulation of the price of a security;

xxx xxx xxx

(g) entering into a transaction in securities without intention of performing it or without intention of change of ownership of such security;

14. The Regulations do not provide a definition for unfair trade practices but "fraud" and "fraudulent" have been defined under Regulation 2(1)(c), which reads as under:

"2(1)(c) "fraud" includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss, and shall also include:

(1) a knowing misrepresentation of the truth or concealment of material fact in order that another person may act to his detriment;

(2) a suggestion as to a fact which is not true by one who does not believe it to be true;

(3) an active concealment of a fact by a person having knowledge or belief of the fact;

(4) a promise made without any intention of performing it;

(5) a representation made in a reckless and careless manner whether it be true or false;

(6) any such act or omission as any other law specifically declares to be fraudulent,

(7) deceptive behavior by a person depriving another of informed consent or full participation,

(8) a false statement made without reasonable ground for believing it to be true.

(9) the act of an issuer of securities giving out misinformation that affects the market price of the security, resulting in investors being effectively misled even though they did not rely on the statement itself or anything derived from it other than the market price. And "fraudulent" shall be construed accordingly; Nothing contained in this clause shall apply to any general comments made in good faith in regard to-

(a) the economic policy of the government

(b) the economic situation of the country

(d) any other matter of a like nature whether such comments are made in public or in private;

xxx xxx xxx

(e) "securities" means securities as defined in section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956)."

15. The Securities and Exchange Board of India (Stock brokers and Sub-brokers) Regulations, 1992 in Schedule II deals with the code of conduct for stockbrokers which reads as follows:

"SCHEDULE II

Securities and Exchange Board of India (Stock Brokers and Sub-brokers) Regulations, 1992

CODE OF CONDUCT FOR STOCK BROKERS

[Regulation 7]

A. General.

(1) Integrity: A stock-broker, shall maintain high standards of integrity, promptitude and fairness in the conduct of all his business.

(2) Exercise of due skill and care : A stock-broker shall act with due skill, care and diligence in the conduct of all his business.

(3) Manipulation : A stock-broker shall not indulge in manipulative, fraudulent or deceptive transactions or schemes or spread rumours with a view to distorting market equilibrium or making personal gains.

(4) Malpractices: A stock-broker shall not create false market either singly or in concert with others or indulge in any act detrimental to the investors interest or which leads to interference with the fair and smooth functioning of the market. A stockbroker shall not involve himself in excessive speculative business in the market beyond reasonable levels not commensurate with his financial soundness.

(5) Compliance with statutory requirements: A stock-broker shall abide by all the provisions of the Act and the rules, regulations issued by the Government, the Board and the Stock Exchange from time to time as may be applicable to him."

16. As the facts pertain to transactions involving certain technical terms, we will have to necessarily deal with their meaning and content.

17. Derivatives - Derivatives are a form of financial instruments which are traded in the securities market and whose values are derived from the value of the underlying variables like the share price of a particular scrip in the cash segment of the market or the stock index of a portfolio of stocks. Derivative trading is governed by Section 18A of the 1956 Act. There are two types of derivative instruments - 'futures' and 'options'. In futures and options, the trading can either be of individual stocks or of indices like NIFTY, Bank NIFTY etc.

18. Futures - a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price agreed upon on the date of the contract. All the futures contracts are settled in cash.

19. Options - options are contracts between a buyer and the seller which gives a right, but not an obligation, to buy or sell the underlying asset at a stated price on or before a specified date. While a buyer of an option pays the premium and buys 13 his right to exercise his option, the writer of an option is the one who receives the option premium and is therefore obliged to sell or buy the asset as per the option exercised by the buyer. Options are of two types, 'Call' and 'Put'. Call Option gives the buyer the right but not the obligation to buy a given quantity of the underlying asset at a given price on or before a given future date. Put Option gives the buyer the right, but not obligation to sell a given quantity of underlying asset at a given price on or before a given future date.

20. The impugned SAT order in the case of Rakhi Trading has succinctly dealt with the working of options: "2. ...The seller in an options contract sells a right to the buyer and since nothing can be sold without a cost, the former charges an amount from the latter which is called the premium. It is this premium which is the only negotiable element in an options contract that is negotiated on the trading screen of the stock exchange.

At the beginning of every trading cycle which is fixed by the concerned stock exchange, it (stock exchange) prescribes in the case of stock options a series of strike rates based upon the prevailing market price of particular shares that are allowed to be traded in the F & O segment. In the case of index options, the strike rates are determined with reference to the index value in the cash segment.

These strike rates are based on the general market perception both bullish and bearish. Equal number of strike rates both upwards and downwards of the prevailing market price/index value are fixed by the stock exchange.

The stock exchange also fixes the size of the contracts that are traded in lots. When an investor chooses to trade in the options contracts, he has to choose a scrip or the Nifty, then assess whether the same will go up or down on the next settlement date and by how much. That is his gamble. Accordingly, he will select a strike rate which is the exercise price. He can then buy or sell a "call Option" or a "Put Option".

A Call Option is an option to "buy", that is, the contract is to buy the shares on a settlement date at the selected strike rate. A Put Option is an option to sell, that is, the contract is to sell the shares on the settlement date at the selected strike rate. In case the price of the underlying or the value of the index in the cash segment goes below the selected strike rate/exercise price, the buyer will have no attraction to exercise his option under the contract and will allow the contract to lapse and thereby lose whatever premium was paid by him. Premium amount is the maximum that the buyer can lose in case the market moves contrary to his perception. In case the price of the underlying or the index value in the cash segment were to go beyond the selected strike rate/exercise price, the buyer would certainly exercise his option under the contract depending upon how high the price or the stock index has gone after adjusting the premium amount.

These are some of the motivating factors which weigh with the investors in the options contracts. It is a one sided contract where the loss suffered, if any, by the buyer is limited only to the premium amount whereas the loss which could be suffered, if any, by the buyer is limited only to the premium amount whereas the loss which could be suffered by the writer of the contract (seller) is limitless. If during the period of the contract the market perception of the seller (writer) changes or the market starts moving contrary to his expectations, he may, in his anxiety to cap his losses, take a reverse position. He would then put in an offer or accept an offer of a higher premium for the same option and this in effect would result in his repurchasing the contract at a higher rate/premium to avoid greater losses."

(Emphasis supplied)

21. Index - a stock market index is a measure of the relative value of a group of stocks in numerical terms. As the stocks within an index change value, the index value changes. NIFTY 50 is an index on National Stock Exchange which tracks the behaviour of 50 companies covering different sectors of the Indian economy.

22. Trading in Index - an investor can trade even the entire stock market by buying index futures instead of buying individual securities. The advantages of trading in index futures are- the contracts are highly liquid, the index futures provide higher leverage than any other stocks, it requires 16 comparatively low initial capital investment (only the premium), it has lower risk than buying and holding stocks, it is just as easy to trade the short side as the long side, the trader needs to study only one index instead of several stocks and finally, the contracts are settled in cash in the stock exchange and therefore, all problems related to bad delivery, fake or forged certificate etc. can be avoided.

23. The case at hand deals, inter alia, with questions related to synchronised trading. The concept of synchronised trading has been explained by SAT in Ketan Parekh v. Securities and Exchange Board of India.

To quote:

"20. .... "A synchronised trade is one where the buyer and seller enter the quantity and price of the shares they wish to transact at substantially the same time. This could be done through the same broker (termed a cross deal) or through two different brokers. Every buy and sell order has to match before the deal can go through. This matching may take place through the stock exchange mechanism or off market. When it matches through the stock exchange, it may or may not be a synchronised deal depending on the time when the buy and sell orders are placed. ..."

Facts:

24. As mentioned before, this case involves three traders and three brokers.

Traders:

Rakhi Trading: Rakhi Trading was issued a show cause notice (hereinafter referred to as "SCN") on 05.10.2007 alleging execution of non genuine transactions in the Futures and Options segment (hereinafter referred to as the "F & O segment"). The trades in question pertain to NIFTY options. In his decision, the A.O. analysed the trade logs and observed that the trades executed by Rakhi Trading matched with the counter-party Kasam Holding Private Limited in a few seconds. The counter-party to all the trades in the NIFTY contract was Kasam Holding Pvt. Ltd. and the reversals took place in a matter of minutes/hours. The A.O. also noted that on various occasions, when the time was not matched by the respective parties, the first order was placed at an unattractive price relative to market price. These transactions took place on 21.03.2007, 22.03.2007. 23.03.2007 and 30.03.2007 and resulted in a close out difference of Rs 115.79 18 lakhs without any significant change in the value of the underlying.

Tungarli: The SCN was issued to Tungarli on 05.10.2007. The allegation in the SCN was that through these synchronized transactions, one party booked profits and the other party booked losses. The trades pertained to future scrips. The A.O.'s order notes that the trades were reversed in all the cases in a matter of few seconds showing significant difference between the buy and sell trade prices. The change in positions took place without any significant change/negligible change in the price of the underlying security. The trades took place on 12.03.2007, 15.03.2007, 23.03.2007, 26.03.2007 and 28.03.2007 and the total profit made by Tungarli was Rs 64.52 lakhs.

TLB: The SCN was issued to TLB on 05.10.2007. The trades pertained to future scrips. As per the A.O.'s order, TLB traded through stock broker SMC Global Securities Ltd and the same broker is the counter party broker as well, trading on behalf of different clients. All the transactions undertaken by TLB resulted in loss to TLB and the total loss was Rs.38.69 lakhs. The trades in question took place on 22.01.2007, 23.01.2007, 31.01.2007, 01.02.2007, 05.02.2007 and 06.02.2007. The A.O.'s order notes that in many cases, the trades were reversed in a matter of minutes showing significant difference in prices without any significant change in value of the underlying. The A.O.'s order notes that during investigation, it was also seen that when the time was not matched by the respective parties, the first order that was placed was at an unattractive price relative to the market price.

Brokers:

Indiabulls : The case pertains to 23 reverse trades in 21 futures and 2 options on 22 different scrips and one Bank Nifty futures. The A.O. takes into account the fact, that in many cases, the reversals took place in a matter of seconds/minutes without change in the value of the underlying. The A.O. records that the Indiabulls representative stated that they could not have known about the intention of the clients, however, the representative admitted that the trades were non-genuine and should not have taken place.

Angel: In the SCN dated 05.10.2007, the charge is that as a stock-broker, it executed 56 reversal trades. As per the A.O., these trades were reversed in a matter of a few minutes/ hours. However, the A.O. noted the positive steps taken by Angel in curbing such trades (post reversal trades) and submitted proof of its actions in this regard and therefore, a lesser penalty was imposed on Angel.

Prashant Jayantila l: The SCN was dated 05.10.2007. The case pertains to 19 reversal trades wherein the original trades were closed out during the day at a price which was significantly above or below the price at which the first/original transaction was executed.

25. The crux of the allegations in the show cause notices is that the parties were buying and selling securities in the derivatives segment at a price which did not reflect the value of the underlying in synchronised and reverse transactions.

26. After affording an opportunity for filing reply to the SCNs and a personal hearing, the A.O. passed a detailed order dated 26.03.2009 in the case of Rakhi Trading. Paragraphs 22 to 24 read as follows:

"22. If the individual trades are seen from the order log provided to the noticee, it is seen that the time difference between the buy and sell order is only in seconds. Most of the orders were matched in a time gap of 1, 2 or 3 seconds and many orders have matched to the exact second, i.e. time difference is 0 (zero).

This is proof enough to establish the existence of synchronization of trades; otherwise the trades would not have matched repeatedly to the exact second in the NIFTY Contracts which is the most active contract in the options segment. Hence it overrides the noticee's submission that no material or data has been disclosed to substantiate the said allegation of "synchronization" of any trades.

23. On analysis of the reversal transactions undertaken by the noticee, it is seen that the percentage to market gross is in the range of 30 percent to 50 percent in the 14 contracts executed by the noticee. In two contracts of NIFTY, the percentage to market gross reached 50 percent. This accounts for a significant percentage of trades on the concerned days and the traded value was Rs.95.75 lakhs for those two reversal trades. The trade quantities are also high. The total traded value is Rs.503.00 lakh in a matter of just 4 (four) trading days. As submitted by the noticee, NIFTY moves constantly.

Also, NIFTY is the most active of the options contracts traded on the exchange and it has contributed to 92.21 percent of the contracts traded in the Options segment during March 2007. Further, the NIFTY options contracts contributed to 99.97 percent of the total Index Options contracts traded in March 2007 (source: NSE website). In such a scenario it is seen that the noticee's counter party to all the trades in NIFTY contracts is Kasam Holding Pvt. Ltd. (trading through the broker Vibrant Securities Private Limited), this clearly gives an indication to the existence of a pre-arrangement/synchronization / matched trades between the clients.

Otherwise it does seem unrealistic that the orders should match exactly both quantity and price wise, just as a matter of coincidence, with the same party again and again. It is clear that there was an intention of creating a false or misleading appearance in the market and also that a manipulative /deceptive device was used for synchronization of trades.

24. The trades executed by the noticee in all NIFTY contracts, matched with the counter party client, Kasam Holding Pvt. Ltd. in less than a few seconds. It is pertinent to note here that the noticee executed all the reversal trades in a matter of minutes/hours, at a profit of Rs.107.79 lakh without any significant change in the value of the underlying security. This raises doubts about the genuineness of the transactions. The fact that such transactions took place repeatedly over a period of time reinstates the fraudulent nature of such trades."

Thus, according to the A.O. a manipulative/deceptive devise was used for synchronization of trades and the trades were fraudulent/fictitious in nature. It was found that there is violation of Regulations 3(a), (b) and (c) and 4(1), (2)(a) and (b) of the PFUTP Regulations, 2003. Consequently, a penalty of Rs.1,08,00,000/- was imposed under Section 15HA of the SEBI Act, 1992. Appeal was filed under Section 15T before the SAT. An appeal was disposed of by order dated 11.10.2010 whereby SAT set aside the order of SEBI. The detailed consideration is available at paragraphs 5 to 8 of the SAT order in Rakhi Trading, which read as follows:

"5. Index in a capital market is a statistical indicator of how the market is functioning and acts as a barometer for market behaviour. It is not a product but a measure expressed in numbers and a benchmark against which financial or economic performance is evaluated. Unlike stocks in the cash segment, it is not traded as such though investors speculate on market behaviour using index as the underlying in the F & O segment. Nifty, the stock index of NSE, is computed using market capitalization weighted method (share price x number of outstanding shares) of fifty stocks being traded in the cash segment of NSE. It is a well diversified stock index covering 22 different sectors of the Indian economy.

The eligibility of a particular stock for being selected for Nifty index depends on the liquidity of the stock as well as the floating stock of the company. Nifty, therefore, is a very dynamic index which is not constant but evolves continuously. Obviously, to manipulate such a diverse and changing portfolio of stocks in the cash segment is extremely difficult, if not impossible by trading in the F & O segment.

It is also NSE's stated position on its website that "stock index is difficult to manipulate as compared to stock prices, more so in India and the possibility of cornering is reduced. This is partly because an individual stock has a limited supply which can be cornered". It is obvious that when Nifty is traded in options contracts, the movement of prices in that segment cannot have any impact on the price discovery system in the cash segment which is one of the allegations brought out in the ad-interim ex-parte order and the show cause notice.

The charge against the appellant in the show cause notice is that by executing trades in Nifty options in the F & O segment "the original trades were closed out during the day at a price which was significantly above or below the price at which the first/original transaction was executed without significant variations in the traded price of the underlying security". The insinuation is that by executing manipulative trades in the F & O segment, Nifty index was sought to be tampered with.

This charge proceeds on the assumption that the movement of Nifty options in the F & O segment should be in harmony with the movement of Nifty index in the cash segment. This assumption is fallacious and we cannot agree. Movement of index in the cash segment does influence the index options in the F & O segment because the strike rate is directly linked with the index value in the cash segment. However, the converse is not always true. While transactions in the cash market are based on the current market price of the underlying derived by the principle of demand and supply and in the case of an index, the value depends on the performance of the stocks that constitute it, the pricing in the F & O segment is based on future expected events which may or may not happen.

Anticipated future events may not have a discernible effect on the cash segment today where delivery of shares is given/taken immediately. Such events may have a great impact on perceptions in the F & O market where the investor holds an open position and a continuous liability during the currency of the contract which is generally for one to three months with anticipation of future events which are always pregnant with all sorts of possibilities. Again, volatility and potential for greater losses may trigger movements in the F & O market without any equivalent cash market movements.

Further, the cash market may move up today but the prediction for the F & O market could be that at the end of a month, two months or three months the market may move down. Only short term investors like speculators trade in the F & O market whereas in the cash market long terms investors also trade. We are, therefore, satisfied that the movement in the two segments need not be in tandem. In the instant case the appellant executed Nifty option contracts and it must be remembered that Nifty index is determined by fifty highly liquid scrips which also vary from time to time and the index moves on the basis of their performance in the cash segment.

These movements cannot be in tandem with the movement of the price of Nifty options in the F & O segment because Nifty as an index is not capable of being traded in the cash segment. What is traded in the cash segment are the fifty stocks which constitute Nifty. To say that some manipulative trades in Nifty options in the F & O segment could influence the Nifty index is too farfetched to be accepted. The only way Nifty index could be influenced is through manipulation of the prices of all or majority of the scrips in the cash segment that constitute Nifty. This is extremely difficult, if not impossible. It is common case of the parties that the appellant traded only 13 Nifty option contracts in the F & O segment.

Assuming these trades were manipulative, could these ever influence the Nifty index. As already observed, Nifty index is a very large well diversified portfolio of stocks which is not capable of being influenced much less manipulated by the movement of prices in the F & O segment particularly by the handful of trades executed by the appellant. In this view of the matter, we have no hesitation to hold that the 13 trades in Nifty options executed by the appellant had no impact on the market or affected the investors in any way nor did these influence the Nifty index in any manner. The charge in this regard must fail.

6. Another charge against the appellant is that its trades in Nifty options were fictitious transactions which were synchronized and reversed resulting in the creation of misleading appearance of trading in those options. Derivative segment is highly volatile and involves a complexed form of trading with high risks and the players in this segment do not follow the herd mentality as is often noticed in the cash segment but take decisions based on their own perception of the market. The number of persons trading in this segment is comparatively much less than those in the cash segment.

The Board has found that only 14 contracts executed by the appellant in the options segment constituted 30 to 50 per cent of the market gross in that segment though nifty is the most active of the options contracts traded on the exchange and contributed 92.21 per cent of the trades during March, 2007. This is indicative of the fact that the number of players in the options segment is very less. Artificial/fictitious trades in the cash segment do give a false appearance of active trading in a particular scrip by increasing volumes which tend to lure the lay investors to invest in that scrip .

The impression given to the investors is that the scrip is highly liquid and much in demand and this interferes with the price discovery mechanism of the exchange and it is for this reason that such trades are held illegal in the cash segment. This, however, cannot be the case in the F & O segment. Since all the trades are executed through the stock exchange and settled in cash through its mechanism they cannot be said to be artificial trades creating a misleading appearance of trading in the options. The charge is misconceived.

7. This brings us to the issue of synchronization of the buy and sell orders in the Nifty option contracts executed by the appellant where the counter party in the 13 impugned transactions was the same entity. Impugned order records that Nifty contracts which are the most active contracts in the options segment cannot be traded in the way the appellant has traded matching its orders to seconds with the counter party client. This, according to the adjudicating officer, was a pre-planned arrangement between the appellant and its counter party and their intention was to create a false and misleading appearance in the market and a manipulative device was used for synchronizing the trades.

The learned senior counsel appearing for the appellant did not dispute the fact that the trades had been synchronized and reversed but he argued that these did not manipulate the market and that only the synchronized trades which manipulate the market are prohibited. He placed reliance on a judgment of this Tribunal in Ketan Parekh vs. Securities and Exchange Board of India, Appeal No.2 of 2004 decided on 14.7.2006. He also referred to the order passed by the Board in the case of ICICI Brokerage Services Ltd. wherein a similar view had been taken and strenuously argued that since the synchronized trades of the appellant did not manipulate the market, the impugned order deserves to be set aside.

We find merit in this contention. The fact that the trades executed by the appellant had been synchronized with the counter party is not really in dispute before us. We have already held that the 13 trades in Nifty options executed by the appellant had no impact on the market or affected the investors or the Nifty index in any manner. In Ketan Parekh's case (supra) this Tribunal had observed that synchronized trades per se are not illegal but only those which manipulate the market in any manner are the ones that are prohibited and violate the Regulations. Relying upon the observations made by this Tribunal in Nirmal Bang Securities Pvt. Ltd. vs. Securities and Exchange Board of India [2004] 49 SCL 421, the then chairman of the Board while dealing with the synchronized trades executed by the appellant therein observed as under:-

"For the above reason, although it cannot be said that synchronized deals are pre se illegal, for the same reason, it cannot be said that 30 all synchronized transactions are legal and permitted. All synchronized transactions which have the effect of manipulating the market are against fair market practices and hence undesirable and prohibited." We have reproduced the observations from the order of the Board only to highlight that the Board also understands that the law is that only such synchronized trades violate the Regulations which manipulate the market. Since the impugned trades of the appellant in the F & O segment had no impact on the market, we hold that they did not violate the Regulations.

Shri Kumar Desai learned counsel for the respondent was equally emphatic in arguing that the appellant had not only executed synchronized trades but had also reversed them during the course of the trading with the same counter party and, therefore, the trades were fictitious and non-genuine and that the adjudicating officer was justified in holding so and imposing the monetary penalty for violating the Regulations. He placed strong reliance on the observations of the Tribunal in Ketan Parekh's case (supra) wherein it has been held that reversal of trades between the same parties results in fictitious trades and they are illegal. We are unable to agree with him.

The observations in Ketan Parekh's case were made with reference to the trades that were executed in the cash segment and we are clearly of the view that all those observations cannot apply to the trades executed in the F & O segment. Reverse trades in the cash segment have been held to be illegal and violate the Regulations because there is no "change of beneficial ownership" in the traded scrip. More- over, in the cash segment the scrip is actually traded entailing not only "change of beneficial ownership" but also physical delivery/movement of the traded scrip.

When this does not happen in the cash segment, the trade is described as a fictitious trade creating false volumes which manipulates the market. The scenario in the F & O segment, particularly in the options contracts with which we are concerned in the present case, is altogether different from that of the cash segment. In the F & O segment there is no concept of "change of beneficial ownership" since what is traded in this segment are contracts and not the underlying stock or index and it is only through cash settlement that the trade is concluded and no physical delivery of any asset is involved. In this view of the matter, synchronized and reversed trades in Nifty options in the F & O segment can never manipulate the market which, in the present context, means the value of the Nifty index in the cash segment.

To repeat, we may again observe that it is almost impossible to manipulate the Nifty index which consists of fifty well diversified highly liquid stocks in the cash segment. Since the trades of the appellant were settled in cash through the stock exchange mechanism, they were genuine and these could not create a false or misleading appearance of trading in the F & O segment. It is the Board's own case that the appellant made profits in all these transactions and the counter party suffered losses.

8. When we analyse the nature of the trades executed by the appellant, we find that it played in the derivative market neither as a hedger nor as a speculator and not even as an arbitrageur. The question that now arises is why did the appellant execute such trades with the counter party in which it continuously made profits and the other party booked continuous losses. All these trades were transacted in March 2007 at the end of the financial year 2006-07.

It is obvious and, this fact was not seriously disputed by the learned senior counsel appearing for the appellant, that the impugned trades were executed for the purpose of tax planning. The arrangement between the parties was that profits and losses would be booked by each of them for effective tax planning to ease the burden of tax liability and it is for this reason that they synchronized the trades and reversed them.

They have played in the market without violating any rule of the game. This Tribunal in Viram Investment Pvt. Ltd. vs. Securities and Exchange Board of India, Appeal no.160 of 2004 decided on February 11, 2005 while dealing with a contention as to whether trades could be executed through the stock exchange for tax planning, made the following observations which are relevant for our purpose:- "Even if we consider transactions undertaken for tax planning as being non genuine trades, such trades in order to be held objectionable, must result in influencing the market one way or the other.

We do not find any evidence of that either in the investigation conducted by the Bombay Stock Exchange, copy of which has been annexed to the memorandum of appeal or in the impugned order that there was any manipulation. ......... Trading in securities can take place for any number of reasons and the authorities enquire into such transactions which artificially influence the market and induce the investors to buy or sell on the basis of such artificial transactions." The observations even though made in the context of the cash segment are equally applicable to the F & O segment.

We are in agreement with the aforesaid observations and relying thereon we hold that the impugned transactions in the case before us do not become illegal merely because they were executed for tax planning as they did not influence the market. The learned counsel for the respondent Board drew our attention to Regulation 3(a), (b) & (c) and Regulation 4(1) and 4(2)(a) & (b) of the Regulations to contend that the trades of the appellant were in violation of these provisions.

We cannot agree with him. Regulation 3 of the Regulations prohibits a person from buying, selling or otherwise dealing in securities in a fraudulent manner or using or employing in connection with purchase or sale of any security any manipulative or deceptive device in contravention of the Act, Rules or Regulations. Similarly, Regulation 4 prohibits persons from indulging in fraudulent or any unfair trade practices in securities which include creation of false or misleading appearance of trading in the securities market or dealing in a security not intended to effect transfer of beneficial ownership. Having carefully considered these provisions, we are of the view that market manipulation of whatever kind, must be in evidence before any charge of violating these Regulations could be upheld. We see no trace of any such evidence in the instant case.

We have, therefore, no hesitation in holding that the charge against the appellant for violating Regulations 3 and 4 must also fail." (Emphasis Supplied) 27. The SAT has also taken a view that the circular dated 10.03.2005 issued by the NSE was not legally binding.

The members were advised to desist from entering orders/transactions on illiquid securities/contracts where some set of members/clients executed reversing transactions/both buy and sell at abnormal price differences in premiums that had no relevance to the movement in prices of the underlying. In the said circular, members were also advised to desist from entering such orders which prima facie appeared to be non-genuine and further advised to put in appropriate internal systems for checking such orders. SAT held that only SEBI-the Regulator can issue and should issue such directions.

28. SAT, in the case of Tungarli, squarely followed its decision in Rakhi Trading. In TLB Securities also, after briefly 35 discussing the facts, SAT relied on Rakhi Trading to set aside the SEBI order.

29. As far as the brokers are concerned, in addition to relying on its decision in Rakhi Trading, SAT held in Indiabulls Securities that the brokers must succeed for two additional reasons. To quote: "7. The appellant before us which is a stock broker must also succeed for two additional reasons as well. The appellant is said to have executed trades on behalf of its clients which were reversed between the same parties.

Assuming that these trades were manipulative and had been executed by the clients with a premeditated plan, the fact still remains that the appellant only acted as a broker and carried out the directions of its clients which it ought to. Could the appellant be held liable merely because it acted as a broker? This question has come up for the consideration of this Tribunal time and again and this is what was held in Kasat Securities Pvt. Ltd. vs. Securities and Exchange Board of India, Appeal No. 27 of 2006 decided on June 20, 2006 wherein this Tribunal observed as under:-

"The trades, on the face of it, appear to be fictitious and we shall proceed on that assumption. It is obvious that these trades were executed by the clients and the appellant acted only as a broker. If the appellant knew that the trades were fictitious then there would be no hesitation in upholding the finding of the Board that it aided 36 and abetted the parties to execute fraudulent transactions. Having heard the learned counsel for the parties and after going through the record we are satisfied that this link is missing.

There is no material on record to show that the appellant as a broker knew that the trades were fictitious or that the buyer and the seller were the same persons. Trading was through the exchange mechanism and was online where the code number of the broker alone is known and the learned counsel for the parties are agreed that it is not possible for anyone to ascertain from the screen as to who the clients were. This is really a unique feature of the stock exchange where, unlike other moveable properties, securities are bought and sold between the unknowns through the exchange mechanism without the buyer or the seller ever getting to meet.

Therefore it was not possible for the broker to know who the parties were. Merely because the appellant acted as a broker cannot lead us to the conclusion that it must have known about the nature of the transaction. There has to be some other material on the record to prove this fact. The Board could have examined someone from KIL to find out whether the appellant knew about the nature of the transactions but it did not do so. As a broker, the appellant would welcome any person who comes to buy or sell shares.

The Board in the impugned order while drawing an inference that the appellant must have known about the nature of the transactions has observed that the appellant failed to enquire from its clients as to why they were wanting to sell the securities. We do not think that any broker would ask such a question from its clients when he is getting business nor is such a question relevant unless, of course, he suspects some wrong doing for which there has to be some material on the record."

In Kishor R. Ajmera vs. Securities and Exchange Board of India, Appeal No. 13 of 2007 decided on February 5, 2008 this Tribunal again observed as under:-

"Merely because two clients have executed matched trades, it does not follow that their brokers were necessarily a party to the game plan. On a screen based trading through the price order matching mechanism of the exchange, it is not possible for either of the brokers (or sub-brokers) to know who the counter party or his broker (or sub broker) is and when the trade is executed, their names or codes do not appear on the screen.

A unique feature of the stock exchange is that, unlike other moveable properties, securities are bought and sold among the 38 unknowns who never get to meet and they are traded at prices determined by the forces of demand and supply. If the Board is to hold the broker (or the sub-broker) responsible for a matching trade, it has to allege and establish that the broker (or the sub-broker) was aware of the counter party or his broker at the time when the trade was executed. There is no such allegation in this case." The aforesaid observations apply with full force to the facts of the present case because the trading system is the same, both in the cash segment as well as in the F & O segment.

As already observed, even if we assume that the appellant's clients had executed reverse trades with the same counter party for some mischief, we cannot impute knowledge of the same to the appellant when the anonymity of the trading system does not allow a broker to know who the counter party or counter party broker is. The screen based trading system provides complete anonymity and the trades are executed through the price order matching mechanism. In the instant case, no link other than broker client relationship between the appellant and its clients has been established, let alone any relation with the counter parties or the counter party brokers.

Moreover, the appellant executed only 23 trades on behalf of clients with a total close out difference of Rs. 35.44 lacs (positive) which have been called in question. Having regard to the fact that the appellant had executed 1,69,71,078 trades for 1,21,306 clients with a turnover of 39 Rs. 1,11,659 crores during the investigation period we are of the view that in terms of materiality and substance this miniscule number of trades done on behalf of 15 clients were not likely to raise any alarm for the appellant with a client base of over 4,70,000 clients. In these circumstances, we cannot hold the appellant liable for the impugned trades.

8. The other additional reason for which we cannot hold the appellant liable is that out of the 23 impugned trades that it executed on behalf of its clients, were executed directly by the clients through the Internet. NSE by its circular of August 24, 2000 has set detailed guidelines on Internet based trading through order routing system which route client orders to the exchange trading system and the software for this service has to be in compliance with the parameters set by the Board.

The appellant as a broker has very little direct control over such trades though it is recorded as a broker in those trades. Having regard to the total volume of trades executed by the appellant and the wide client base that it has, the learned counsel for the appellant was right in contending that the appellant could not be expected to put every single trade under its scanner on a continuous basis particularly those executed by the clients through the Internet and that the impugned trades being so miniscule, there was no occasion for the appellant to get a red alert. It is a fact that the clients had sufficient margins with the appellant with no credit defaults at any stage and that all the trades were settled in cash through the clearing system of the exchange.

In this background, we find no 40 evidence of lack of due diligence on the part of the appellant while executing the impugned transactions which could make him guilty of violating the code of conduct prescribed for the stock brokers. The charge must, therefore, fail." 30. Aggrieved by the SAT orders, SEBI is before us under Section 15Z of the SEBI Act.

31. We have extensively heard learned senior counsel and other counsel appearing on both sides. SEBI has assailed the SAT order on the ground that SAT has misunderstood SEBI's case. It is the submission of Mr. Gourab Banerji, learned Senior Counsel appearing for SEBI, that the stock exchange is a platform created to facilitate efficient and fair trading. However, the transactions between the parties were non-genuine and orchestrated which is prohibited under the PFUTP Regulations. The Show Cause Notice makes it clear that the transactions were a misuse of market mechanism as they were not genuine trades. The non-genuineness of these transactions is evident from the fact that there was no commercial basis to suddenly, within a matter of minutes, reverse a transaction when the value of the underlying had not undergone any significant change.

32. According to SAT, the synchronization and reversal of trades effected by the parties with a significant price difference, some in a few seconds and majority, in any case, on the same day had no impact on the market and it has not affected the NIFTY index in any manner or induced investors. SAT has held that such trades are illegal only when they manipulate the market in any manner and induce investors. It has also taken a view that there being no physical delivery of any asset, there is no change of beneficial ownership and what is traded in the F & O segment are only contracts and hence, such synchronised and reverse trades in NIFTY options in the F & O segment "can never manipulate the market".

It has also held that the trades being settled in cash through a stock exchange mechanism, are genuine and therefore cannot create a false or misleading appearance of trading in the F & O segment. Further, any trade to be objectionable must result in influencing the market one way or the other. SAT held that these trades were for the purpose of tax planning which is not violative of any regulation. We are not inclined to get in to the issue of tax planning as it was not mentioned in the show cause notices.

33. We find it difficult to appreciate the stand taken by the SAT which is endorsed by the learned senior counsel appearing for the respondents. Mr. Chidambaram, learned senior counsel appearing for Rakhi Trading argues that the SAT decision is valid and proper. Reliance is also placed on the case of Ketan Parekh (supra) in which SAT held that synchronised trades are not per se illegal. As far as reversal of trades is concerned, the senior counsel has sought to distinguish Ketan Parekh (supra) as it pertained to dealings in the cash segment whereas the present case deals with the F & O segment. The learned senior counsel has strenuously argued that no rules of the game have been violated.

34. We are unable to agree with the arguments of the learned senior counsel appearing for Rakhi Trading. Regulation 4(1) in clear and unmistakable terms has provided that "no person shall indulge in a fraudulent or an unfair trade practice in securities". In Securities and Exchange Board of India and Ors. v. Shri Kanaiyalal Baldevbhai Patel 43 and Ors.3, it has been held by this Court that a trade practice is unfair if the conduct undermines the ethical standards and good faith dealings between the parties engaged in business transactions. To quote:

"31. Although unfair trade practice has not been defined under the regulation, various other legislations in India have defined the concept of unfair trade practice in different contexts. A clear cut generalized definition of the 'unfair trade practice' may not be possible to be culled out from the aforesaid definitions. Broadly trade practice is unfair if the conduct undermines the ethical standards and good faith dealings between parties engaged in business transactions.

It is to be noted that unfair trade practices are not subject to a single definition; rather it requires adjudication on case to case basis. Whether an act or practice is unfair is to be determined by all the facts and circumstances surrounding the transaction. In the context of this regulation a trade practice may be unfair, if the conduct undermines the good faith dealings involved in the transaction. Moreover the concept of 'unfairness' appears to be broader than and includes the concept of 'deception' or 'fraud'.

xxx xxx xxx

60. Coupled with the above, is the fact, the said conduct can also be 3 2017 SCC Online SC 1148. 44 construed to be an act of unfair trade practice, which though not a defined expression, has to be understood comprehensively to include any act beyond a fair conduct of business including the business in sale and purchase of securities. However the said question, as suggested by my learned Brother, Ramana, J. is being kept open for a decision in a more appropriate occasion as the resolution required presently can be made irrespective of a decision on the said question."

35. Having regard to the fact that the dealings in the stock exchange are governed by the principles of fair play and transparency, one does not have to labour much on the meaning of unfair trade practices in securities. Contextually and in simple words, it means a practice which does not conform to the fair and transparent principles of trades in the stock market. In the instant case, one party booked gains and the other party booked a loss. Nobody intentionally trades for loss. An intentional trading for loss per se, is not a genuine dealing in securities.

The platform of the stock exchange has been used for a non-genuine trade. Trading is always with the aim to make profits. But if one party consistently makes loss and that too in preplanned and rapid reverse trades, it is not genuine; it is an unfair trade practice. Securities market, as the 1956 Act provides in the preamble, does not permit "undesirable transactions in securities". The Act intends to prevent undesirable transactions in securities by regulating the business of dealing therein.

Undesirable transactions would certainly include unfair practices in trade. The SEBI Act, 1992 was enacted to protect the interest of the investors in securities. Protection of interest of investors should necessarily include prevention of misuse of the market. Orchestrated trades are a misuse of the market mechanism. It is playing the market and it affects the market integrity.

36. Ordinarily, the trading would have taken place between anonymous parties and the price would have been determined by the market forces of demand and supply. In the instant case, the parties did not stop at synchronised trading. The facts go beyond that. The trade reversals in this case indicate that the parties did not intend to transfer beneficial ownership and through these orchestrated transactions, the intention of which was not regular trading, other investors have been excluded from participating in 46 these trades. The fact that when the trade was not synchronizing, the traders placed it at unattractive prices is also a strong indication that the traders intended to play with the market.

37. We also find it difficult to appreciate the stand of SAT that the rationale of change of beneficial ownership does not arise in the derivatives segment. No doubt, as in the case of trade in a scrip in the cash segment, there is no physical delivery of the asset. However, even in the derivative segment there is a change of rights in a contract. In the instant case, through reverse trades, there was no genuine change of rights in the contract.

SAT has erred in its understanding of change in beneficial ownership in reverse trades. Even in derivatives, the ownership of the right is restored to the first party when the reverse trade occurs. In this context, the discussion in Ketan Parekh (supra) assumes significance:

"20. ...As already observed 'synchronisation' or a negotiated deal ipso facto is not illegal. A synchronised transaction will, however, be illegal or violative of the Regulations if it is executed with a view to manipulate the market or if it results in circular trading or is dubious in nature and is executed with a view to avoid regulatory detection or does not involve change of beneficial ownership or is executed to create false volumes resulting in upsetting the market equilibrium. Any transaction executed with the intention to defeat the market mechanism whether negotiated or not would be illegal.

Whether a transaction has been executed with the intention to manipulate the market or defeat its mechanism will depend upon the intention of the parties which could be inferred from the attending circumstances because direct evidence in such cases may not be available.

The nature of the transaction executed, the frequency with which such transactions are undertaken, the value of the transactions, whether they involve circular trading and whether there is real change of beneficial ownership, the conditions then prevailing in the market are some of the factors which go to show the intention of the parties. This list of factors, in the very nature of things, cannot be exhaustive.

Any one factor may or may not be decisive and it is from the cumulative effect of these that an inference will have to be drawn." (Emphasis Supplied) From the facts before us